Why Retailers Go Expansion Crazy

It has a lot to do with juicing sales, and it's not always the best idea.

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H&M, one of the largest clothing retailers in the world, is in rapid expansion mode. In the past year, it has opened 365 stores worldwide, increasing its retail footprint by 12.7 percent to 3,246 stores. In 2014, the fast-fashion juggernaut plans on opening a total of 375 outposts - more than one a day. The company's sales are also increasing. Last month, sales were up an impressive 17 percent from April 2013. But given that the adage "you've got to spend money to make money" is usually pretty right, it's no surprise that H&M's profit margins have suffered for it. Operating profits increased by 9 percent in the first quarter of 2014, but would have been more in the range of 14 percent if H&M hadn't invested so much in store expansion, according to execs.

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Uniqlo, too, is making a major push. While its first efforts to conquer the U.S. market in 2005 faltered -- it turns out a New Jersey mall was not the way to introduce a brand to Americans -- its first New York flagship, opened in 2006, was a major success. Another followed in 2011, and by the end of 2014, Uniqlo will have 39 stores in the U.S., almost doubling its Stateside doors in just one year.

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For retailers in their heyday, crazy-fast expansion appears to be worth it. Because, while investors in favor of sustainable growth would prefer that a company not milk expansion for all its worth early on, the stock market demands something different. The idea is to keep sales up, and to also capitalize on popularity. "The more stores in a market, the bigger base to leverage marketing, distribution, management, human resources, A&E costs, etc.," says Mary Brett Whitfield, senior vice president at Columbus, Ohio-based consulting firm Kantar Retail. "Of course, new concepts want to open as many stores as they can to take advantage of positive market sentiment and popularity."

Right now, the H&Ms, Zaras and Uniqlos of the world are particularly well-poised to strike in the U.S. "The only concepts worthy of more space, and in the process of developing more space, are the fast-fashion retailers," says Brian Sozzi, CEO of the New York-based firm stock market research firm Belus Capital Advisors. "They have the sales momentum, and they have the traditional chains retreating from malls across the United States."

But retail is inherently cyclical, and eventually a newer concept will usurp fast fashion, potentially putting it in the place currently occupied by speciality retailers. "They’re looking to ride the bubble when the opportunity is there, without thinking long term," says Allan Ellinger, senior managing partner of MMG, a New York-based investment bank and restructuring advisor in the fashion and retail industries. "But no business enjoys uninterrupted upward momentum -- ultimately they’re bound to hit a speed bump or lose customer appeal, because you can’t be right year in year out. They over-expand while the customer is moving onto the next big idea."

It's a tough lesson that many brands are only learning now. "The entire retail playbook of opening stores to juice sales, and later profits, is in the process of being unwound," says Sozzi. "Baby boomer retail executives were bred with the mindset that to grow a business and keep it healthy, it had to open 50-100 stores a year. There will be hundreds upon hundreds of new dark storefronts come January 2015, all the direct result of a lack of foresight by executives in 2007 and 2008." Abercrombie & Fitch plans to close 180 stores by 2015. Aeropostale will close 175 stores in the coming years, including 40-50 in 2014 alone.

Gap, Inc., too, plans to close stores--more than 70 in 2014 -- but it also plans to open another 185, many in Asia. Indeed, another big problem for retailers operating in the U.S. is that there are just too many stores here. Retailers occupy more than 14.2 billion square feet of space, according to the 2007 Economic Census, which equals 46.6 square feet per capita. In the UK, retail space equals 23 square feet per capita. (Granted, it's a much smaller country in size; retail is still highly concentrated there.) But in Australia, Asia and South America there is simply more room. And in turn, more opportunity.

Fast-fashion retailers have undoubtedly planned for the challenges specialty retailers -- and before that, department stores -- are currently facing. "Retailers are thinking about what makes the right location. Not just looking at existing sales, but taking in demographics, and making sure there's an understanding of the role of the store in the [long term]," says Adam Pressman, a partner in the retail practice of A.T. Kearney, a Chicago-based management consulting firm. He says retailers are also spending their money more wisely, resulting in an "accelerated return on investment." Adds Ellinger, "The strategy works only when retailers keep it precious, and when they understand how to create scarcity. It backfires when they overexpose themselves to a point where they cannibalize their own stores."

Yet there is one thing that could trip them all up: the Internet. Yes, e-commerce startups have begun to open physical stores, though those outposts often serve more as a branding vehicle than a sales driver. More significantly, shoppers are doing more research via the web. Instead of browsing at a mall, they're browsing the product online and then heading straight to the store to pick it up. (Nearly 80 percent of shoppers claim they do this, according to a report published by market research firm Live Person.) And while e-commerce sales still only make up 6.2 percent of total retail sales in the U.S., according to the Census, that number won't stop rising. The big challenge of the next 20 years won't only be to keep shoppers happy with the offline experience, but also with the online one. "We encourage our clients to not be too draconian one way or another," says Pressman, who advises retailers to use stores as a way to experiment, get feedback and evaluate the way customers are spending money. "In-store shopping is still very significant."

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